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Transferring Business Ownership

File C4-14
Updated April, 2007

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The time and method of transferring personal property (i.e., machinery and livestock) from the older party to the younger party should fit within the overall business transfer plan. The transfer of real property (land and buildings) may be influenced by estate planning considerations.

The ownership of farm assets can be transferred by sale or gift during the parents’ life, or at death according to the parents’ will or under state law if there is no will. Each transfer method has tax consequences, so you should discuss all options with your tax advisor.

Machinery

Various methods of transferring machinery ownership to the young person are presented below. The value of machinery can be determined with an appraisal by either a dealer or an auctioneer.

Sale
Two considerations in a machinery sale are the cash-flow needs of the buyer (younger party) and the income tax consequences to the seller (older party). In an outright sale where a full cash payment is made at the time of sale, taxes resulting from depreciation recapture and capital gains are due in the year of the sale.

With an installment sale, the cash payments are spread over a period of years. However, depreciation recapture and capital gains on depreciable property between related parties are included as taxable income in the year of sale. You may want to check with your tax advisor on the minimum interest rate allowable for tax purposes. An alternative is to sell one machine per year to spread out the depreciation recapture and capital gains.

Ownership may be transferred when the machine is traded. If the new machine is to be owned jointly, the value of the trade-in can count towards the older party’s contribution to the new machine. To simplify record keeping for a jointly owned machinery line, the ownership division should be the same for each item (for example, 50-50). An alternative is for each party to own specific machinery items.

Gift
Gifting machinery usually will not trigger income taxes but may have gift tax consequences. With a gifting program, the income tax basis of the machine will transfer from the person giving the property (older person) to the recipient (younger party). A gift tax may be incurred for gifts not covered by the annual gift tax exclusion of $12,000 (2006-adjusted annually for inflation) per recipient. The gift must be a gift of "present interest" to be eligible. Check with your tax advisor for specifics on your situation.

The equitable treatment of other children is a concern with a gifting program. If a gift is made to the farming child, should a gift of equal value be made to non-farming children?

Leasing
A leasing program may be of value if the young person has limited capital. The size of the lease payment should be based on the cost of owning the machine (depreciation, return on investment, insurance and housing) and may run from 15 percent to 20 percent of the machine’s value. A decision should be made on who pays for repairs and major overhauls.

Feed and livestock

Strategies for transferring feed and livestock ownership are discussed below. Often feed and livestock ownership is adjusted to the same percentage as the livestock income is divided.

Breeding livestock
The older party may sell a portion of the breeding herd to the younger party. An installment sale may be used. Also a roll-over approach can be used with breeding livestock. The older party continues to own the breeding herd but the offspring is owned jointly with the younger party. When the original breeding animals are sold, the older party receives the income from the cull sale. Subsequently raised replacements are owned jointly.

Feed and market livestock
An ownership interest in the feed and market livestock can be sold or given to the young person. One approach is to transfer ownership at the low point of the feed inventory (just before harvest), or between the sale and subsequent replacement of market livestock. Another alternative is to transfer ownership over two tax years by making transfers at the end of one tax year and the beginning of the next tax year.

Instead of selling the young person an interest in the market livestock on hand, the livestock can be inventoried. When the livestock is subsequently sold, the original owner (older party) will receive the inventory value of the livestock with the remaining proceeds divided between both parties. Be careful that the use of the inventory concept does not change your "method of accounting" for income tax reporting purposes.

Land

Land can be transferred during life by sale or gift, or at death. Often land is held by the older party until death, although a building site may be transferred earlier.

Transfer by sale
Land can be sold to the young person. The two major options are the cash sale and the installment sale, although other options such as the private annuity exist. A cash sale may not automatically reduce estate and inheritance tax liability because the sale proceeds may be taxed in the estate at the eventual death of the parents.

An installment sale can be used to spread the sale proceeds over several years with the original owner (older party) using the annual payments for living expenses. However, periods of inflation will reduce the real value of the fixed annual payments and, over a period of years, may substantially shrink the purchasing power of their income. Conversely, during a period of deflation the real value of the annual payments will increase, which may place a financial hardship on the buyer (younger party). Also, because the term of the contract is a fixed number of years, the seller (older party) may outlive the income stream.

Transfer by gift
Land can be given to the children. Each person (donor) can give up to $12,000 (2006-adjusted annually for inflation) of property each year to as many people as he/she would like, with no gift tax due. Together, a husband and wife can give $24,000 each year, even though the property is owned by only one of them. A substantial amount of land can be transferred if there are several recipients. Remember, with a gift the parents give up ownership of the property. So if income from the property is needed to cover living expenses, or if the property is needed as security during retirement, a gift program should not be used. Information File Gift Tax provides more information on this tax.

Transfer by will
Land is often transferred at death according to the decedent’s will. Transferring land at death allows the parents to use the property and receive income from it all through retirement. The major taxes assessed on property passing at death are the Federal Estate Tax and the Iowa Inheritance Tax. Information File Federal Estate Tax provides information on this tax.

The Iowa Inheritance Tax is assessed on property passing to each heir. Information File Iowa Inheritance Tax provides information on this tax.

Transfers at death may be eligible for Special Use Valuation and the 15-year Installment Payment of Federal Estate Tax.

Income tax considerations

The method used to transfer land will greatly affect income tax liability. This is especially true of land with a low income tax basis. If the land is transferred by sale, the seller (older party) pays income tax on the amount of gain between the tax basis and the sale value of the property. The buyer (younger party) receives the property with a new basis equal to the purchase price. If the land is transferred by gift, the parents pay no income tax and the child takes over the parents’ tax basis. If the property is passed at death, the parents pay no income tax on the gain and the child receives the property with a new tax basis equal to the federal estate tax value (usually the fair market value) in the estate. The gain on the difference between the original tax basis and the market value at death is not taxed. Obviously, there is often a substantial income tax advantage of transferring land and other property at death compared to transfers during life. Information File Income Tax Aspects of Property Transfers provides more information.